A good date to start studying commodity prices and evaluating the madness of crowds is today
if you want to make profits in trading and go the opposite of the crowds . . . Commodities futures markets have been
described as continuous auction markets and as clearing
houses for current information about commodity supply and demand
conditions. They are meeting places of buyers and sellers
of an expanding list of commodities that today includes
agricultural products, gold and metals, petroleum, financial
instruments, foreign currencies and stock indexes. Trading
has also been initiated in options on commodities contracts,
enabling option buyers to participate in futures markets
with known risks.

In addition to fast growth and diversification
of commodity futures markets, another important purpose is the
same as it has been for nearly a century and a half,
to provide an efficient and effective mechanism for
the management of price risks, also known as
commodities hedging.
By buying or selling commodity futures contracts -- contracts
establishing price levels NOW for items to be delivered
at a LATER date -- individuals and businesses seek to
achieve what amounts to insurance against adverse price
changes. This is called commodity-hedging.

Other commodities futures market participants
are speculative investors who accept the risks that
hedgers wish to avoid. Most speculators have no intention
of making or taking delivery of the commodity but, rather,
seek to profit from a change in the price. That is,
they buy when they anticipate rising prices and sell
when they anticipate declining prices. The interaction
of hedgers and speculators helps to provide active,
liquid and competitive markets. Speculative participation
in futures trading has become increasingly attractive
with the availability of alternative methods of participation.
Whereas many commodities futures traders continue to
prefer to make their own trading decisions -- such as
what to buy and sell and when to buy and sell -- others
choose to utilize the services of a professional trading
advisor, or to avoid day-to-day trading responsibilities
by establishing a fully managed trading account or participating
in a commodity pool which is similar in concept to a
mutual fund.

For those individuals who fully understand
and can afford the risks which are involved, the allocation
of some portion of their capital to futures trading
can provide a means of achieving greater diversification
and a potentially higher overall rate of return on their
investments. There are also a number of ways in which
futures can be used in combination with stocks, bonds and other investments.

Speculation in futures contracts,
however, is clearly not appropriate for everyone. Just
as it is possible to realize substantial profits in
a short period of time, it is also possible to incur
substantial losses in a short period of time. The possibility
of large profits or losses in relation to the initial
commitment of capital stems principally from the fact
that futures trading is a highly leveraged form of speculation.
Only a relatively small amount of money is required
to control assets having a much greater value. As we
will discuss and illustrate, the leverage of futures
trading can work for you when prices move in the direction
you anticipate or against you when prices move in the
opposite direction.

It is not the purpose of this brochure
to suggest that you should -- or should not -- participate
in futures trading. That is a decision you should make
only after consultation with your broker or financial
advisor and in light of your own financial situation
and objectives.

Intended to help provide you with
the kinds of information you should first obtain -- and
the questions you should seek answers to -- in regard
to any investment you are considering:

Information about the investment
itself and the risks involved

How readily your investment or
position can be liquidated when such action is necessary
or desired

Who the other market participants
are

Alternate methods of participation

How prices are arrived at

The costs of trading

How gains and losses are realized

What forms of regulation and protection
exist

The experience, integrity and
track record of your broker or advisor

The financial stability of the
firm with which you are dealing

In sum, the information you need to
be an informed investor.

Futures Market

The frantic shouting and signaling of bids and offers
on the trading floor of a futures exchange undeniably
convey an impression of chaos. The reality however,
is complete chaos is what the futures markets replaced.
Prior to the establishment of central grain markets
in the mid-nineteenth century, the nation farmers carted
their newly harvested crops over plank roads to major
population and transportation centers each fall in search
of buyers. The seasonal glut drove prices to giveaway
levels and, indeed, to throwaway levels as grain often
rotted in the streets or was dumped in rivers and lakes
for lack of storage. Come spring, shortages frequently
developed and foods made from corn and wheat became
barely affordable luxuries. Throughout the year, it
was each buyer and seller for himself with neither a
place nor a mechanism for organized, competitive bidding.
The first central markets were formed to meet this need.
Eventually, contracts were entered into for forward
as well as for spot (immediate) delivery. So-called
forwards were the forerunners of present day futures
contracts.

Spurred by the need to manage price and interest rate
risks that exist in virtually every type of modern business,
today's futures markets have also become major financial
markets. Participants include mortgage bankers as well
as farmers, bond dealers as well as grain merchants,
and multinational corporations as well as food processors,
savings and loan associations, and individual speculators.

Futures prices arrived at through competitive bidding
are immediately and continuously relayed a round the
world by wire and satellite. A farmer in Nebraska, a
merchant in Amsterdam, an importer in Tokyo and a speculator
in Ohio thereby have simultaneous access to the latest
market-derived price quotations. And, should they choose,
they can establish a price level for future delivery -- or
for speculative purposes -- simply by having their broker
buy or sell the appropriate contracts. images created
by the fast-paced activity of the trading floor notwithstanding,
regulated futures markets are a keystone of one of the
world's most orderly envied and intensely competitive
marketing systems. Should you at some time decide to
trade in futures contracts, either for speculation or
in connection with a risk management strategy, your
orders to buy or sell would be communicated by phone
from the brokerage office you use and then to the trading
pit or ring for execution by a floor broker. If you
are a buyer, the broker will seek a seller at the lowest
available price. If you are a seller, the broker will
seek a buyer at the highest available price. That's
what the shouting and signaling is about.

In either case, the person who takes the opposite
side of your trade may be or may represent someone who
is a commercial hedger or perhaps someone who is a public
speculator. Or, quite possibly, the other party may
be an independent floor trader. In becoming acquainted
with futures markets, it is useful to have at least
a general understanding of who these various market
participants are, what they are doing and why.

Hedgers

The details of hedging can be somewhat complex but
the principle is simple. Hedgers are individuals and
firms that make purchases and sales in the futures market
solely for the purpose of establishing a known price
level -- weeks or months in advance -- for something they
later intend to buy or sell in the cash market (such
as at a grain elevator or in the bond market). In this
way they attempt to protect themselves against the risk
of an unfavorable price change in the interim. Or hedgers
may use futures to lock in an acceptable margin between
their purchase cost and their selling price. Consider
this example:

A jewelry manufacturer will need to buy additional
gold from his supplier in six months. Between now and
then, however, he fears the price of gold may increase.
That could be a problem because he has already published
his catalog for a year ahead.

To lock in the price level at which gold is presently
being quoted for delivery in six months, he buys a futures
contract at a price of, say, $350 an ounce.

If, six months later, the cash market price of gold
has risen to $370, he will have to pay his supplier
that amount to acquire gold. However, the extra $20
an ounce cost will be offset by a $20 an ounce profit
when the futures contract bought at $350 is sold for
$370. In effect, the hedge provided insurance against
an increase in the price of gold. It locked in a net
cost of $350, regardless of what happened to the cash
market price of gold. Had the price of gold declined
instead of risen, he would have incurred a loss on his
futures position but this would have been offset by
the lower cost of acquiring gold in the cash market.

The number and variety of hedging possibilities is
practically limitless. A cattle feeder can hedge against
a decline in livestock prices and a meat packer or supermarket
chain can hedge against an increase in livestock prices.
Borrowers can hedge against higher interest rates, and
lenders against lower interest rates. Investors can
hedge against an overall decline in stock prices, and
those who anticipate having money to invest can hedge
against an increase in the over-all level of stock prices.
And the list goes on.

Whatever the hedging strategy, the common denominator
is that hedgers willingly give up the opportunity to
benefit from favorable price changes in order to achieve
protection against unfavorable price changes.

Speculators

Were you to speculate in futures contracts, the person
taking the opposite side of your trade on any given
occasion could be a hedger or it might well be another
speculator -- someone whose opinion about the probable
direction of prices differs from your own.

The arithmetic of speculation in futures contracts -- including
the opportunities it offers and the risks it involves -- will
be discussed in detail later on. For now, suffice it
to say that speculators are individuals and firms who
seek to profit from anticipated increases or decreases
in futures prices. In so doing, they help provide the
risk capital needed to facilitate hedging.

Someone who expects a futures price to increase would
purchase futures contracts in the hope of later bring
able to sell them at a higher price. This is known as
"going long." Conversely, someone who expects
a futures price to decline would sell futures contracts
in the hope of later being able to buy back identical
and offsetting contracts at a lower price. The practice
of selling futures contracts in anticipation of lower
prices is known as "going short." One of the
attractive features of futures trading is that it is
equally easy to profit from declining prices (by selling)
as it is to profit from rising prices (by buying).

Floor Traders

Persons known as floor traders or locals, who buy
and sell for their own accounts on the trading floors
of the exchanges, are the least known and understood
of all futures market participants. Yet their role is
an important one. Like specialists and market makers
at securities exchanges, they help to provide market
liquidity. If there isn't a hedger or another speculator
who is immediately willing to take the other side of
your order at or near the going price, the chances are
there will be an independent floor trader who will do
so, in the hope of minutes or even seconds later being
able to make an offsetting trade at a small profit.
In the grain markets, for example, there is frequently
only one-fourth of a cent a bushel difference between
the prices at which a floor trader buys and sells.

Floor traders, of course, have no guarantee they will
realize a profit. They may end up losing money on any
given trade. Their presence, however, makes for more
liquid and competitive markets. It should be pointed
out, however, that unlike market makers or specialists,
floor traders are not obligated to maintain a liquid
market or to take the opposite side of customer orders.

Reasons for Buying
futures contracts

Reasons for Selling
futures contracts

Hedgers

To lock in a price and thereby obtain protection
against rising prices

To lock in a price and thereby obtain protection
against declining prices

There are two types of futures
contracts, those that provide for physical delivery
of a particular commodity or item and those which call
for a cash settlement. The month during which delivery
or settlement is to occur is specified. Thus, a July
futures contract is one providing for delivery or settlement
in July.

It should be noted that even in the case of delivery-type
futures contracts, very few actually result in delivery.
Not many speculators have the desire to take or make
delivery of, say, 5,000 bushels of wheat, or 112,000
pounds of sugar, or a million dollars worth of U.S.
Treasury bills for that matter. Rather, the vast majority
of speculators in futures markets choose to realize
their gains or losses by buying or selling offsetting
futures contracts prior to the delivery date. Selling
a contract that was previously purchased liquidates
a futures position in exactly the same way, for example,
that selling 100 shares of IBM stock liquidates an earlier
purchase of 100 shares of IBM stock. Similarly, a futures
contract that was initially sold can be liquidated by
an offsetting purchase. In either case, gain or loss
is the difference between the buying price and the selling
price.

Even hedgers generally don't make or take delivery.
Most, like the jewelry manufacturer illustrated earlier,
find it more convenient to liquidate their futures positions
and (if they realize a gain) use the money to offset
whatever adverse price change has occurred in the cash
market.

When delivery does occur it is in the form of a negotiable
instrument (such as a warehouse receipt) that evidences
the holder's ownership of the commodity, at some designated
location.

Why Delivery?

Since delivery on futures contracts is the exception
rather than the rule, why do most contracts even have
a delivery provision? There are two reasons. One is
that it offers buyers and sellers the opportunity to
take or make delivery of the physical commodity if they
so choose. More importantly, however, the fact that
buyers and sellers can take or make delivery helps to
assure that futures prices will accurately reflect the
cash market value of the commodity at the time the contract
expires, i.e., that futures and cash prices will eventually
converge. It is convergence that makes hedging an effective
way to obtain protection against an adverse change in
the cash market price.

Convergence occurs at the expiration of the futures
contract because any difference between the cash and
futures prices would quickly be negated by profit-minded
investors who would buy the commodity in the lowest-price
market and sell it in the highest-price market until
the price difference disappeared. This is known as arbitrage
and is a form of trading generally best left to professionals
in the cash and futures markets.

Cash settlement futures contracts are precisely that,
contracts which are settled in cash rather than by delivery
at the time the contract expires. Stock index futures
contracts, for example, are settled in cash on the basis
of the index number at the close of the final day of
trading. There is no provision for delivery of the shares
of stock that make up the various indexes. That would
be impractical. With a cash settlement contract, convergence
is automatic.

The Process of Price Discovery

Futures prices increase and decrease largely because
of the myriad factors that influence buyers' and sellers'
judgments about what a particular commodity will be
worth at a given time in the future (anywhere from less
than a month to more than two years).

As new supply and demand developments occur and as
new and more current information becomes available,
these judgments are reassessed and the price of a particular
futures contract may be bid upward or downward. The
process of reassessment of price discovery is continuous.

Thus, in January, the price of a July futures contract
would reflect the consensus of buyers' and sellers'
opinions at that time as to what the value of a commodity
or item will be when the contract expires in July. On
any given day, with the arrival of new or more accurate
information, the price of the July futures contract
might increase or decrease in response to changing expectations.

Competitive price discovery is a major economic function
and, indeed, a major economic benefit of futures trading.
The trading floor of a futures exchange is where available
information about the future value of a commodity or
item is translated into the language of price. In summary,
futures prices are an ever changing barometer of supply
and demand and, in a dynamic market, the only certainty
is that prices will change.

After the Closing Bell

Once a closing bell signals the end of a day's trading,
the exchange's clearing organization matches each purchase
made that day with its corresponding sale and tallies
each member firm's gains or losses based on that day's
price changes a massive undertaking considering that
nearly two-thirds of a million futures contracts are
bought and sold on an average day. Each firm, in turn,
calculates the gains and losses for each of its customers
having futures contracts. The good thing about this option is that it is less complicated and does not involve challenging decision-making processes.

Gains and losses on futures contracts are not only
calculated on a daily basis, they are credited and deducted
on a daily basis. Thus, if a speculator were to have,
say, a $300 profit as a result of the day's price changes,
that amount would be immediately credited to his brokerage
account and, unless required for other purposes, could
be withdrawn. On the other hand, if the day's price
changes had resulted in a $300 loss, his account would
be immediately debited for that amount.

The process just described is known as a daily cash
settlement and is an important feature of futures trading.
As will be seen when we discuss margin requirements,
it is also the reason a customer who incurs a loss on
a futures position may be called on to deposit additional
funds to his account.

The Arithmetic of Futures
Trading

To say that gains and losses in futures trading are
the result of price changes is an accurate explanation
but by no means a complete explanation. Perhaps more
so than in any other form of speculation or investment,
gains and losses in futures trading are highly leveraged.
An understanding of leverage and of how it can work
to your advantage or disadvantage is crucial to an understanding
of futures trading.

As mentioned in the introduction, the leverage of
futures trading stems from the fact that only a relatively
small amount of money (known as initial margin) is required
to buy or sell a futures contract. On a particular day,
a margin deposit of only $1,000 might enable you to
buy or sell a futures contract covering $25,000 worth
of soybeans. Or for $6,000, you might be able to purchase
a futures contract covering common stocks worth $100,000.
The smaller the margin in relation to the value of the
futures contract, the greater the leverage.

If you speculate in futures contracts and the price
moves in the direction you anticipated, high leverage
can produce large profits in relation to your initial
margin. Conversely, if prices move in the opposite direction,
high leverage can produce large losses in relation to
your initial margin. Leverage is a two-edged sword.

For example, assume that in anticipation of rising
stock prices you buy one June S&P 500 stock index
futures contract at a time when the June index is trading
at 1200. And assume your initial margin requirement
is $25,000. Since the value of the futures contract
is $250 times the index, each 1 point change in the
index re presents a $250 gain or loss.

Thus, an increase in the index from 1200 to 1300 would
double your $25,000 margin deposit and a decrease from
1200 to 1100 would wipe it out. That's a 100% gain or
loss as the result of only an 8-1/2% change in the stock
index!

Said another way, while buying (or selling) a futures
contract provides exactly the same dollars and cents
profit potential as owning (or selling short) the actual
commodities or items covered by the contract, low margin
requirements sharply increase the percentage profit
or loss potential. For example, it can be one thing
to have the value of your portfolio of common stocks
decline from $100,000 to $94,000 (a 6% loss) but quite
another (at least emotionally) to deposit $6,000 as
margin for a futures contract and end up losing that
much or more as the result of only a 6% price decline.
Futures trading thus requires not only the necessary
financial resources but also the necessary financial
and emotional temperament.

Trading

An absolute requisite for anyone considering trading
in futures contracts whether it's sugar or stock indexes,
pork bellies or petroleum is to clearly understand the
concept of leverage as well as the amount of gain or
loss that will result from any given change in the futures
price of the particular futures contract you would be
trading. If you cannot afford the risk, or even if you
are uncomfortable with the risk, the only sound advice
is don't trade. Futures trading is not for everyone.

Margins

As is apparent from the preceding discussion, the
arithmetic of leverage is the arithmetic of margins.
An understanding of margins and of the several different
kinds of margin is essential to an understanding of
futures trading.

If your previous investment experience has mainly involved
common stocks, you know that the term margin as used
in connection with securities has to do with the cash
down payment and money borrowed from a broker to purchase
stocks. But used in connection with futures trading,
margin has an altogether different meaning and serves
an altogether different purpose.

Rather than providing a down payment, the margin required
to buy or sell a futures contract is solely a deposit
of good faith money that can be drawn on by your brokerage
firm to cover losses that you may incur in the course
of futures trading. It is much like money held in an
escrow account. Minimum margin requirements for a particular
futures contract at a particular time are set by the
exchange on which the contract is traded. They are typically
about five percent of the current value of the futures
contract. Exchanges continuously monitor market conditions
and risks and, as necessary, raise or reduce their margin
requirements. Individual brokerage firms may require
higher margin amounts from their customers than the
exchange-set minimums.

There are two margin-related terms you should know:
Initial margin and maintenance margin.

Initial margin (sometimes called original
margin) is the sum of money that the customer must deposit
with the brokerage firm for each futures contract to
be bought or sold. On any day profits may accrue on
your open positions, trading profits will be added to
the balance in your margin account. On any day losses
accrue, the losses will be deducted from the balance
in your margin account.

If and when the funds remaining available in your
margin account are reduced by losses to below a certain
level known as the maintenance margin
requirement your broker will require that you deposit
additional funds to bring the account back to the level
of the initial margin. Or, you may also be asked for
additional margin if the exchange or your brokerage
firm raises its margin requirements. Requests for additional
margin are known as margin calls.

Assume, for example, that the initial margin needed
to buy or sell a particular futures contract is $2,000
and that the maintenance margin requirement is $1,500.
Should losses on open positions reduce the funds remaining
in your trading account to, say, $1,400 (an amount less
than the maintenance requirement), you will receive
a margin call for the $600 needed to restore your account
to $2,000.

Before trading in futures contracts, be sure you understand
the brokerage firm's Margin Agreement and know how and
when the firm expects margin calls to be met. Some firms
may require only that you mail a personal check. Others
may insist you wire transfer funds from your bank or
provide same-day or next-day delivery of a certified
or cashier's check. If margin calls are not met in the
prescribed time and form, the firm can protect itself
by liquidating your open positions at the available
market price (possibly resulting in an unsecured loss
for which you would be liable).

Basic Trading Strategies

Even if you should decide to participate in futures
trading in a way that doesn't involve having to make
day-to-day trading decisions (such as a managed account
or commodity pool), it is nonetheless useful to understand
the dollars and cents of how futures trading gains and
losses are realized. And, of course, if you intend to
trade your own account, such an understanding is essential.

Dozens of different strategies and variations of strategies
are employed by futures traders in pursuit of speculative
profits. Here is a brief description and illustration
of several basic strategies.

Buying (Going Long) to Profit
from an Expected Price Increase

Someone expecting the price of a
particular commodity or item to increase over from a
given period of time can seek to profit by buying futures
contracts. If correct in forecasting the direction and
timing of the price change, the futures contract can
later be sold for the higher price, thereby yielding
a profit. If the price declines rather than increases,
the trade will result in a loss. Because of leverage,
the gain or loss may be greater than the initial margin
deposit.

For example, assume it's now January, the July soybean futures contract is presently quoted
at $6.00, and over the coming months you expect the
price to increase. You decide to deposit the required
initial margin of, say, $1,500 and buy one July soybean
futures contract. Further assume that by April the July
soybean futures price has risen to $6.40 and you decide
to take your profit by selling. Since each contract
is for 5,000 bushels, your 40-cent a bushel profit would
be 5,000 bushels x 40 cents or $2,000 less transaction
costs.

Price per bushel

Value of 5,000 bushel contract

January

Buy 1 July soybean futures
contract

$6.00

$30,000 nt

April

Sell 1 July soybean futures
contract

$6.40

$32,000

Gain

$ .40

$ 2,000

For simplicity
examples do not take into account commissions and other
transaction costs. These costs are important, however,
and you should be sure you fully understand them.

Suppose, however, that rather than
rising to $6.40, the July soybean futures price had
declined to $5.60 and that, in order to avoid the possibility
of further loss, you elect to sell the contract at that
price. On 5,000 bushels your 40-cent a bushel loss would
thus come to $2,000 plus transaction costs.

Price per bushel

Value of 5,000 bushel contract

January

Buy 1 July soybean futures
contract

$6.00

$30,000

April

Sell 1 July bean futures
contract

$5.60

$28,000

Loss

$ .40

$ 2,000

Note that the loss in this example exceeded
your $1,500 initial margin. Your broker would then call upon
you, as needed, for additional margin funds to cover the loss.

(Going short) to profit from an expected
price decrease The only way going short to profit from an
expected price decrease differs from going long to profit
from an expected price increase is the sequence of the trades.
Instead of first buying a futures contract, you first sell
a futures contract. If, as expected, the price declines, a
profit can be realized by later purchasing an offsetting futures
contract at the lower price. The gain per unit will be the
amount by which the purchase price is below the earlier selling
price.

For example, assume that in January your
research or other available information indicates a probable
decrease in cattle prices over the next several months. In
the hope of profiting, you deposit an initial margin of $2,000
and sell one April live cattle futures contract at a price
of, say, 65 cents a pound. Each contract is for 40,000 pounds,
meaning each 1 cent a pound change in price will increase
or decrease the value of the futures contract by $400. If,
by March, the price has declined to 60 cents a pound, an offsetting
futures contract can be pur chased at 5 cents a pound below
the original selling price. On the 40,000 pound contract,
that's a gain of 5 cents x 40,000 lbs or $2,000 less transaction
costs.

Price per pound

Value of 40,000 pound contract

January

Sell 1 April live cattle futures
contract

65 cents

$26,000

March

Buy 1 April live cattle futures
contract

60 cents

$24,000

Gain

5 cents

$ 2,000

Assume you were wrong. Instead of decreasing,
the April live cattle futures price increases to, say, 70
cents a pound by the time in March when you eventually liquidate
your short futures position through an off-setting purchase.
The outcome would be as follows:

Price per pound

Value of 40,000 pound contract

January

Sell 1 April live cattle futures
contract

65 cents

$26,000

March

Buy 1 April live cattle futures
contract

70 cents

$28,000

Loss

5 cents

$2,000

In this example,
the loss of 5 cents a pound on the futures transaction resulted
in a total loss of the $2,000 you deposited as initial margin
plus transaction costs.

Spreads

While most speculative futures transactions revolve a simple
purchase of futures contracts to profit from an expected price
increase or an equally simple sale to profit from an expected
price decrease -- numerous other possible strategies exist.
Spreads are one example.

A spread, at least in its simplest form, involves buying
one futures contract and selling another futures contract.
The purpose is to profit from an expected change in the relationship
between the purchase price of one and the selling price of
the other.

As an illustration, assume it's now November, that the March
wheat futures price is presently $3.10 a bushel and the May
wheat futures price is presently $3.15 a bushel, a difference
of 5 cents. Your analysis of market conditions indicates over
the next few months, the price difference between the two
contracts will widen to become greater than 5 cents. To profit
if you are right, you could sell the March futures contract
(the lower priced contract) and buy the May wheat futures
contract (the higher priced contract).

Assume time and events prove you right and that, by February,
the March futures price has risen to $3.20 and May futures
price is $3.35, a difference of 15 cents. By liquidating both
contracts at this time, you can realize a net gain of 10 cents
a bushel. Since each contract is 5,000 bushels, the total
gain is $500.

November

Sell March wheat

Buy May wheat

Spread

$3.10 Bu.

$3.15 Bu.

5 cents

February

Buy March wheat

Sell May wheat

$3.20

$3.35

15 cents

$.10 loss

$.20 gain

Net gain 10 cents Bu. Gain on 5,000 Bu. contract $500

Had the spread (i.e. the price difference) narrowed by 10
cents a bushel rather than widened by 10 cents a bushel the
transactions just illustrated would have resulted in a loss
of $500.

Virtually unlimited numbers and types of spread possibilities
exist, as do many other, even more complex futures trading
strategies. These, however, are beyond the scope of an introductory
booklet and should be considered only by someone who well
understands the risk/reward arithmetic involved.

Participating in Futures Trading

Now that you have an overview of what futures markets are,
why they exist and how they work, the next step is to consider
various ways in which you may be able to participate in futures
trading. There are a number of alternatives and the only best
alternative -- if you decide to participate at all -- is whichever
one is best for you. Also discussed is the opening of a futures
trading account, the regulatory safeguards provided participants
in futures markets, and methods for resolving disputes, should
they arise.

Deciding How to Participate

At the risk of oversimplification, choosing
a method of participation is largely a matter of deciding
how directly and extensively you,
personally, want to be involved in making trading decisions
and managing your account. Many futures traders prefer to
do their own research and analysis and make their own decisions
about what and when to buy and sell. That is, they manage
their own futures trades in much the same way they would manage
their own stock portfolios. Others choose to rely on or at
least consider the recommendations
of a brokerage firm or account executive. Some purchase in
dependent trading advice. Others would rather have
someone else be responsible for trading their account
and therefore give trading authority to their broker. Still
others purchase an interest in a commodity trading pool.

There's no formula for deciding. Your decision
should, however, take into account such things as your knowledge
of and any previous experience in futures trading, how much
time and attention you are able to devote to trading, the
amount of capital you can afford to commit to futures, and,
by no means least, your individual temperament and tolerance
for risk. The latter is important. Some individuals thrive
on being directly involved in the fast pace of futures trading,
others are unable, reluctant, or lack the time to make the
immediate decisions that are frequently required. Some recognize
and accept the fact that futures trading all but inevitably
involves having some losing trades. Others lack the necessary
disposition or discipline to acknowledge that they were wrong
on this particular occasion and liquidate the position.

Many experienced traders thus suggest that,
of all the things you need to know before trading in futures
contracts, one of the most important is to know yourself.
This can help you make the right decision about whether to
participate at all and, if so, in what way.

In no event, it bears repeating, should
you participate in futures trading unless the capital you
would commit its risk capital. That is, capital which, in
pursuit of larger profits, you can afford to lose. It should
be capital over and above that needed for necessities, emergencies,
savings and achieving your long-term investment objectives.
You should also understand that, because of the leverage involved
in futures, the profit and loss fluctuations may be wider
than in most types of investment activity and you may be required
to cover deficiencies due to losses over and above what you
had expected to commit to futures.

Trade Your Own Account

This involves opening your individual trading
account and with or without the recommendations of the brokerage
firm making your own trading decisions. You will also be responsible
for assuring that adequate funds are on deposit with the brokerage
firm for margin purposes, or that such funds are promptly
provided as needed.

Practically all of the major brokerage
firms you are familiar with, and many you may not be familiar
with, have departments or even separate divisions to serve
clients who warn to allocate some portion of their investment
capital to futures trading. All brokerage firms conducting
futures business with the public must be registered with the
Commodity Futures Trading Commission (CFTC, the independent
regulatory agency of the federal government that administers
the Commodity Exchange Act) as Futures Commission Merchants
or Introducing Brokers and must be Members of National Futures Association (NFA, the industry
wide self-regulatory association).

Different firms offer different services.
Some, for example, have extensive research departments and
can provide current information and analysis concerning market
developments as well as specific trading suggestions. Others tailor
their services to clients who prefer to make market judgments
and arrive at trading decisions on their own. Still others
offer various combinations of these and other services.

An individual trading account can be opened
either directly with a Futures Commission Merchant or indirectly
through an Introducing Broker. Whichever course you
choose, the account itself will be carried by a Futures Commission
Merchant, as will your money. Introducing Brokers do not accept
or handle customer funds but most offer a variety of trading-related
services.

Futures Commission Merchants are required
to maintain the funds and property of their customers in segregated
accounts, separate from the firm's own money.

Along with the particular services a firm
provides, discuss the commissions and trading costs that will
be involved. And, as mentioned, clearly understand how the
firm requires that any margin calls be met. If you have a
question about whether a firm is properly registered with
the CFTC and is a Member of NFA, you can (and should) contact NFA's
Information Center toll-free at 800-621-3570 (within Illinois
call 800-572-9400).

Have Someone Manage Your Account

A managed account is also your individual
account. The major difference is that you give someone rise -- an
account manager -- written power of attorney to make and execute
decisions about what and when to trade. He or she will have
discretionary authority to buy or sell for your account or
will contact you for approval to make trades he or she suggests.
You, of course, remain fully responsible for any losses which
may be incurred and, as necessary, for meeting margin calls,
including making up any deficiencies that exceed your margin
deposits.

Although an account manager is likely to
be managing the accounts of other persons at the same time,
there is no sharing of gains or losses of other customers.
Trading gains or losses in your account will result solely
from trades which were made for your account.

Many Futures Commission Merchants and Introducing
Brokers accept managed accounts. In most instances, the amount
of money needed to open a managed account is larger than the
amount required to establish an account you intend to trade
yourself. Different firms and account managers, however, have
different requirements and the range can be quite wide. Be
certain to read and understand all of the literature and agreements
you receive from the broker.

Some account managers have their own trading
approaches and accept only clients to whom that approach is
acceptable. Others tailor their trading to a client's objectives.
In either case, obtain enough information and ask enough questions
to assure yourself that your money will be managed in a way
that's consistent with your goals.

Discuss fees. In addition to commissions
on trades made for your account, it is not uncommon for account
managers to charge a management fee, and/or there may be some
arrangement for the manager to participate in the net profits
that his management produces. These charges are required to
be fully disclosed in advance. Make sure you know about every
charge to be made to your account and what each charge is
for.

While there can be no assurance that past
performance will be indicative of future performance, it can
be useful to inquire about the track record of an account
manager you are considering. Account managers associated with
a Futures Commission Merchant or Introducing Broker must generally
meet certain experience requirements if the account is to
be traded on a discretionary basis.

Finally, take note of whether the account
management agreement includes a provision to automatically
liquidate positions and close out the account if and when
losses exceed a certain amount. And, of course, you should
know and agree on what will be done with profits, and what,
if any, restrictions apply to withdrawals from the account.

Use a Commodity Trading Advisor

As the term implies, a Commodity Trading
Advisor is an individual (or firm) that, for a fee, provides
advice on commodity trading, including specific trading recommendations
such as when to establish a particular long or short position
and when to liquid ate that position. Generally, to help you
choose trading strategies that match your trading objectives,
advisors offer analyses and judgments as to the prospective
rewards and risks of the trades they suggest. Trading recommendations
may be communicated by phone, wire or mail. Some offer the
opportunity for you to phone when you have questions and some
provide a frequently updated hot line you can call for a recording
of current information and trading advice.

Even though you may trade on the basis
of an advisor's recommendations, you will need to open your
own account with, and send your margin payments directly to,
a Futures Commission Merchant. Commodity Trading Advisors
cannot accept or handle their customers funds unless they
are also registered as Futures Commission Merchants.

Some Commodity Trading Advisors offer managed
accounts. The account itself, however, must still be with
a Futures Commission Merchant and in your name, with the advisor
designated in writing to make and execute trading decisions
on a discretionary basis.

CFTC Regulations require that Commodity
Trading Advisors provide their customers, in advance, with
what is called a Disclosure Document. Read it carefully and
ask the Commodity Trading Advisor to explain any points you
don't understand. If your money is important to you, so is
the information contained in the Disclosure Document!

The prospectus-like document contains information
about the advisor, his experience and, by no means least,
his current (and any previous) performance records. If you
use an advisor to manage your account, he must first obtain
a signed acknowledgment from you that you have received and
understood the Disclosure Document. As in any method of participating
in futures trading, discuss and understand the advisor's fee
arrangements. And if he will be managing your account, ask
the same questions you would ask of any account manager you
are considering.

Commodity Trading Advisors must be registered
as such with the CFTC, and those that accept authority to
manage customer accounts must also be Members of NFA.
You can verify that these requirements have been met by calling
NFA toll-free at 800-621-3570.

Participate in a Commodity Pool

Another alternative method of participating
in futures trading is through a commodity pool, which is similar
in concept to a common stock mutual fund. It is the only method
of participation in which you will not have your own individual
trading account. Instead, your money will be combined with
that of other pool participants and, in effect, traded as
a single account. You share in the profits or losses of the
pool in proportion to your investment in the pool. One potential
advantage is greater diversification of risks than you might
obtain if you were to establish your own trading account.
Another is that your risk of loss is generally limited to
your investment in the pool, because most pools are formed
as limited partnerships. And you won't be subject to margin
calls.

Bear in mind, however, that the risks which
a pool incurs in any given futures transaction are no different
than the risks incurred by an individual trader. The pool
still trades in futures contracts which are highly leveraged
and in markets which can be highly volatile. And like an individual
trader, the pool can suffer substantial losses as well as
realize substantial profits. A major consideration, therefore,
is who will be managing the pool in terms of directing its
trading.

While a commodity pool must execute all
of its trades through a brokerage firm which is registered
with the CFTC as a Futures Commission Merchant, it may or
may not have any other affiliation with the brokerage firm.
Some brokerage firms, to serve those customers who prefer
to participate in commodity trading through a pool, either
operate or have a relationship with one or more commodity
trading pools. Other pools operate independently.

A Commodity Pool Operator cannot accept
your money until it has provided you with a Disclosure Document
that contains information about the pool operator, the pool's
principals and any outside persons who will be providing trading
advice or making trading decisions. It must also disclose
the previous performance records, if any, of all persons who
will be operating or advising the pool lot, if none, a statement
to that effect). Disclosure Documents contain important information
and should be carefully read before you invest your money.
Another requirement is that the Disclosure Document advise
you of the risks involved.

In the case of a new pool, there is frequently
a provision that the pool will not begin trading until (and
unless) a certain amount of money is raised. Normally, a time
deadline is set and the Commodity Pool Operator is required
to state in the Disclosure Document what that deadline is
(or, if there is none, that the time period for raising, funds
is indefinite). Be sure you understand the terms, including
how your money will be invested in the meantime, what interest
you will earn (if any), and how and when your investment will
be returned in the event the pool does not commence trading.

Determine whether you will be responsible
for any losses in excess of your investment in the pool. If
so, this must be indicated prominently at the beginning of
the pool's Disclosure Document.

Ask about fees and other costs, including
what, if any, initial charges will be made against your investment
for organizational or administrative expenses. Such information
should be noted in the Disclosure Document. You should also
determine from the Disclosure Document how the pool's operator
and advisor are compensated. Understand, too, the procedure
for redeeming your shares in the pool, any restrictions that
may exist, and provisions for liquidating and dissolving the
pool if more than a certain percentage of the capital were
to be lost,

Ask about the pool operator's general trading
philosophy, what types of contracts will be traded, whether
they will be day-traded, etc.

With few exceptions, Commodity Pool Operators
must be registered with the CFTC and be Members of NFA. You can verify that these requirements
have been met by contacting NFA toll-free at 800-621-3570
(within Illinois call 800-572-9400).

Regulation of Futures Trading

Firms and individuals that conduct futures trading business
with the public are subject to regulation by the CFTC and
by NFA.
All futures exchanges are also regulated by the CFTC.

NFA is a congressionally authorized self-regulatory organization
subject to CFTC oversight. It exercises regulatory Authority
with the CFTC over Futures Commission Merchants, Introducing
Brokers, Commodity Trading Advisors, Commodity Pool Operators
and Associated Persons (salespersons) of all of the foregoing.
The NFA staff consists of more than 140 field auditors and
investigators. In addition, NFA has the responsibility for
registering persons and firms that are required to be registered
with the CFTC.

Firms and individuals that violate NFA rules of professional
ethics and conduct or that fail to comply with strictly enforced
financial and record-keeping requirements can, if circumstances
warrant, be permanently barred from engaging in any futures-related
business with the public. The enforcement powers of the CFTC
are similar to those of other major federal regulatory agencies,
including the power to seek criminal prosecution by the Department
of Justice where circumstances warrant such action.

Futures Commission Merchants which are members of an exchange
are subject to not only CFTC and NFA regulation but to regulation
by the exchanges of which they are members. Exchange regulatory
staffs are responsible, subject to CFTC oversight, for the
business conduct and financial responsibility of their member
firms. Violations of exchange rules can result in substantial
fines, suspension or revocation of trading privileges, and
loss of exchange membership.

Words of Caution

It is against the law for any person or firm to offer futures
contracts for purchase or sale unless those contracts are
traded on one of the nation's regulated futures exchanges
and unless the person or firm is registered with the CFTC.
Moreover, persons and firms conducting futures-related business
with the public must be Members of NFA. Thus, you should be
extremely cautious if approached by someone attempting to
sell you a commodity-related investment unless you are able
to verify that the offeror is registered with the CFTC and
is a Member of NFA.

In a number of cases, sellers of illegal off-exchange futures
contracts have labeled their investments by different names -- such
as "deferred delivery," "forward" or "partial
payment" contracts -- in an attempt to avoid the strict
laws applicable to regulated futures trading. Many operate
out of telephone boiler rooms, employ high-pressure and misleading
sales tactics, and may state that they are exempt from registration
and regulatory requirements. This, in itself, should be reason
enough to conduct a check before you write a check.

You can quickly verify whether a particular firm or person
is currently registered with the CFTC and is an NFA
Member by phoning NFA toll-free at 800-621-3570 (within Illinois
call 800-572-9400).

Establishing an Account

At the time you apply to establish
a futures trading account, you can expect to be asked
for certain information beyond simply your name, address and
phone number. The requested information will generally include
(but not necessarily be limited to) your income, net worth,
what previous investment or futures trading experience you
have had, and any other information needed in order to advise
you of the risks involved in trading futures contracts. At
a minimum, the person or firm who will handle your account
is required to provide you with risk disclosure documents
or statements specified by the CFTC and obtain written acknowledgment
that you have received and understood them.

Opening a futures account is a serious decision -- no less
so than making any major financial investment -- and should
obviously be approached as such. Just as you wouldn't consider
buying a car or a house without carefully reading and understanding
the terms of the contract, neither should you establish a
trading account without first reading and understanding the
Account Agreement and all other documents supplied by your
broker. It is in your interest and the firm's interest that
you dearly know your rights and obligations as well as the
rights and obligations of the firm with which you are dealing
before you enter into any futures transaction. If you have
questions about exactly what any provisions of the Agreement
mean, don't hesitate to ask. A good and continuing relationship
can exist only if both parties have, from the outset, a clear
understanding of the relationship.

Nor should you be hesitant to ask, in advance, what services
you will be getting for the trading commissions the firm charges.
As indicated earlier, not all firms offer identical services.
And not all clients have identical needs. If it is important
to you, for example, you might inquire about the firm's research
capability, and whatever reports it makes available to clients.
Other subjects of inquiry could be how transaction and statement
information will be provided, and how your orders will be
handled and executed.

If a Dispute Should Arise

All but a small percentage of transactions involving regulated
futures contracts take place without problems or misunderstandings.
However, in any business in which some 150 million or more
contracts are traded each year, occasional disagreements are
inevitable. Obviously, the best way to resolve a disagreement
is through direct discussions by the parties involved. Failing
this, however, participants in futures markets have several
alternatives (unless some particular method has been agreed
to in advance).

Under certain circumstances, it may be possible to seek
resolution through the exchange where the futures contracts
were traded. Or a claim for reparations may be filed with
the CFTC. However, a newer, generally faster and less expensive
alternative is to apply to resolve the disagreement through
the arbitration program conducted by National Futures Association.
There are several advantages:

You can elect, if you prefer, to have arbitrators who
have no connection with the futures industry.

You do not have to allege or prove that any law or rule
was broken only that you were dealt with improperly or
unfairly.

In some cases, it may be possible to conduct arbitration
entirely through written submissions. If a hearing is
required, it can generally be scheduled at a time and
place convenient for both parties.

Unless you wish to do so, you do not have to employ an
attorney.

For a plain language explanation of the arbitration program
and how it works, write or phone NFA for a copy of Arbitration:
A Way to Resolve Futures-Related Disputes. The booklet is
available at no cost.

What to Look for in a Futures Contract?

Whatever type of investment you are considering -- including
but not limited to futures contracts -- it makes sense to begin
by obtaining as much information as possible about that particular
investment. The more
you know in advance, the less likely there will be surprises
later on. Moreover, even among futures contracts, there are
important differences which -- because they can affect your
investment results -- should be taken into account in making
your investment decisions.

The Contract Unit

Delivery-type futures contracts stipulate the specifications
of the commodity to be delivered (such as 5,000 bushels of
grain, 40,000 pounds of livestock, or 100 troy ounces of gold).
Foreign currency futures provide for delivery of a specified
number of marks, francs, yen, pounds or pesos. U.S. Treasury
obligation futures are in terms of instruments having a stated
face value (such as $100,000 or $1 million) at maturity. Futures
contracts that call for cash settlement rather than delivery
are based on a given index number times a specified dollar
multiple. This is the case, for example, with stock index
futures. Whatever the yardstick, it's important to know precisely
what it is you would be buying or selling, and the quantity
you would be buying or selling.

How Prices are Quoted

Futures
prices are usually quoted the same way prices are quoted
in the cash market (where a cash market exists). That is,
in dollars, cents, and sometimes fractions of a cent, per
bushel, pound or ounce; also in dollars, cents and increments
of a cent for foreign currencies; and in points and percentages
of a point for financial instruments. Cash settlement contract
prices are quoted in terms of an index number, usually stated
to two decimal points. Be certain you understand the price
quotation system for the particular futures contract you are
considering.

Minimum Price Changes

Exchanges establish the minimum amount that the price can
fluctuate upward or downward. This is known as the "tick"
For example, each tick for grain is 0.25 cents per bushel.
On a 5,000 bushel futures contract, that's $12.50. On a gold
futures contract, the tick is 10 cents per ounce, which on
a 100 ounce contract is $10. You'll want to familiarize yourself
with the minimum price fluctuation -- the tick size -- for whatever
futures contracts you plan to trade. And, of course, you'll
need to know how a price change of any given amount will affect
the value of the contract.

Daily Price Limits

Exchanges establish daily price limits for trading in futures
contracts. The limits are stated in terms of the previous
day's closing price plus and minus so many cents or dollars
per trading unit. Once a futures price has increased by its
daily limit, there can be no trading at any higher price until
the next day of trading. Conversely, once a futures price
has declined by its daily limit, there can be no trading at
any lower price until the next day of trading. Thus, if the
daily limit for a particular grain is currently 10 cents a
bushel and the previous day's settlement price was $3.00,
there can not be trading during the current day at any price
below $2.90 or above $3.10. The price is allowed to increase
or decrease by the limit amount each day.

For some contracts, daily price limits are eliminated during
the month in which the contract expires. Because prices can
become particularly volatile during the expiration month (also
called the "delivery" or "spot" month),
persons lacking experience in futures trading may wish to
liquidate their positions prior to that time. Or, at the very
least, trade cautiously and with an understanding of the risks
which may be involved.

Daily price limits set by the exchanges are subject to change.
They can, for example, be increased once the market price
has increased or decreased by the existing limit for a given
number of successive days.

Because of daily price limits, there may be occasions when
it is not possible to liquidate an existing futures position
at will. In this event, possible alternative strategies should
be discussed with a broker

Position Limits

Although the average trader is unlikely to ever approach
them, exchanges and the CFTC establish limits on the maximum
speculative position that any one person can have at one time
in any one futures contract. The purpose is to prevent one
buyer or seller from being able to exert undue influence on
the price in either the establishment or liquidation of positions.
Position limits are stated in number of contracts or total
units of the commodity.

The easiest way to obtain the types of trader information
just discussed is to ask your broker or other advisor to provide
you with a copy of the contract specifications for the specific
futures contracts you are thinking about trading. Or you can
obtain the information from the exchange where the contract
is traded.

Understanding (and Managing)

Anyone buying or selling futures contracts should clearly
understand that the Risks of any given transaction may result
in a Futures Trading loss. The loss may exceed not only the
amount of the initial margin but also the entire amount deposited
in the account or more. Moreover, while there are a number
of steps which can be taken in an effort to limit the size
of possible losses, there can be no guarantees that these
steps will prove effective. Well-informed futures traders
should, nonetheless, be familiar with available risk management
possibilities.

Choosing a Futures

Just as different common stocks or different bonds may involve
different degrees of probable risk. and reward at a particular
time, so may different futures contracts. The market for one
commodity may, at present, be highly volatile, perhaps because
of supply-demand uncertainties which -- depending on future
developments -- could suddenly propel prices sharply higher
or sharply lower. The market for some other commodity may
currently be less volatile, with greater likelihood that prices
will fluctuate in a narrower range. You should be able to
evaluate and choose the futures contracts that appear -- based
on present information -- most likely to meet your objectives
and willingness to accept risk.

Keep in mind, however, that neither past nor even present
price behavior provides assurance of what will occur in the
future. Prices that have been relatively stable may become
highly volatile (which is why many individuals and firms choose
to hedge against unforeseeable price changes).

Liquidity

There can be no ironclad assurance that, at all times, a
liquid market will exist for offsetting a futures contract
that you have previously bought or sold. This could be the
case if, for example, a futures price has increased or decreased
by the maximum allowable daily limit and there is no one presently
willing to buy the futures contract you want to sell or sell
the futures contract you want to buy.

Even on a day-to-day basis, some contracts and some delivery
months tend to be more actively traded and liquid than others.
Two use full indicators of liquidity are the volume of trading
and the open interest (the number of open futures positions
still remaining to be liquidated by an offsetting trade or
satisfied by delivery). These figures are usually reported
in newspapers that carry futures quotations. The information
is also available from your broker or advisor and from the
exchange where the contract is traded.

Timing

In futures trading, being right about the direction of prices
isn't enough. It is also necessary to anticipate the timing
of price changes. The reason, of course, is that an adverse
price change may, in the short run, result in a greater loss
than you are willing to accept in the hope of eventually being
proven right in the long run.

Example: In January, you deposit initial margin of $1,500
to buy a May wheat futures contract at $3.30 -- anticipating
that, by spring, the price will climb to $3.50 or higher No
sooner than you buy the contract, the price drops to $3.15,
a loss of $750. To avoid the risk of a further loss, you have
your broker liquidate the position. The possibility that the
price may now recover -- and even climb to $3.50 or above -- is
of no consolation.

The lesson to be learned is that deciding when to buy or
sell a futures contract can be as important as deciding what
futures contract to buy or sell. In fact, it can be argued
that timing is the key to successful futures trading.

Stop Orders

A stop order is an order, placed with your broker, to buy
or sell a particular futures contract at the market price
if and when the price reaches a specified level. Stop orders
are often used by futures traders in an effort to limit the
amount they. might lose if the futures price moves against
their position. For example, were you to purchase a crude
oil futures contract at $21.00 a barrel and wished to limit
your loss to $1.00 a barrel, you might place a stop order
to sell an off-setting contract if the price should fall to,
say, $20.00 a barrel. If and when the market reaches whatever
price you specify, a stop order becomes an order to execute
the desired trade at the best price immediately obtainable.

There can be no guarantee, however, that it will be possible
under all market conditions to execute the order at the price
specified. In an active, volatile market, the market price
may be declining (or rising) so rapidly that there is no opportunity
to liquidate your position at the stop price you have designated.
Under these circumstances, the broker's only obligation is
to execute your order at the best price that is available.

In the event that prices have risen or fallen by the maximum
daily limit, and there is presently no trading in the contract
(known as a "lock limit" market), it may not be
possible to execute your order at any price. In addition,
although it happens infrequently, it is possible that markets
may be lock limit for more than one day, resulting in substantial
losses to futures traders who may find it impossible to liquidate
losing futures positions.

Subject to the kinds of limitations just discussed, stop
orders can nonetheless provide a useful tool for the futures
trader who seeks to limit his losses. Far more often than
not, it will be possible. for the broker to execute a stop
order at or near the specified price.

In addition to providing a way to limit losses, stop orders
can also be employed to protect profits. For instance, if
you have bought crude oil futures at $21.00 a barrel and the
price is now at $24.00 a barrel, you might wish to place a
stop order to sell if and when the price declines to $23.00.
This (again subject to the described limitations of stop orders)
could protect $2.00 of your existing $3.00 profit while still
allowing you to benefit from any continued increase in price.

Spreads

Spreads involve the purchase of one futures contract and
the sale of a different futures contract in the hope of profiting
from a widening or narrowing of the price difference. Because
gains and losses occur only as the result of a change in the
price difference -- rather than as a result of a change in the
overall level of futures prices -- spreads are often considered
more conservative and less risky than having an outright long
or short futures position. In general, this may be the case.

It should be recognized, though, that the loss from a spread
can be as great as -- or even greater than -- that which might
be incurred in having an outright futures position. An adverse
widening or narrowing of the spread during a particular time
period may exceed the change in the overall level of futures
prices, and it is possible to experience losses on both of
the futures contracts involved (that is, on both legs of the
spread).

Options on Futures Contracts

What are known as put and call options are being traded
on a growing number of futures contracts. One of the main
appeals of buying options is to make it possible to speculate
on increasing or decreasing futures prices with a known and
also a limited risk. The most the buyer of an option can lose
is the cost of purchasing the option (known as the option
"premium") plus transaction costs.

Options can be most easily understood when put and call
options are considered separately, since, in fact, they are
totally separate and distinct. Buying or selling a call in
no way involves a put, and buying or selling a put in no way
involves a call.

Buying Call Options

The buyer of a call option acquires the right but not the
obligation to purchase (go long) a particular futures contract
at a specified price at any time during the life of the option.
Each option specifies the commodity futures contract which
may be purchased (known as the "underlying" futures
contract) and the price at which it can be purchased (known
as the "exercise" or "strike" price).

A March Treasury bond 84 call option would convey the right
to buy one March U.S. Treasury bond futures contract at a
price of $84,000 at any time during the life of the option.

One reason for buying call options is to profit from an
anticipated increase in the underlying futures price. A call
option buyer will realize a net profit if, upon exercise,
the underlying futures price is above the option exercise
price by more than the premium paid for the option. Or a profit
can be realized it, prior to expiration, the option rights
can be sold for more than they cost.

Example: You expect lower interest rates to result in higher
bond prices (interest rates and bond prices move inversely).
To profit if you are right, you buy a June T-bond 82 call.
Assume the premium you pay is $2,000.

If, at the expiration of the option (in May) the June T-bond
futures price is 88, you can realize a gain of 6 (that's $6,000)
by exercising or selling the option that was purchased at
82. Since you paid $2,000 for the option, your net profit
is $4,000 less transaction costs.

As mentioned, the most that an option buyer can lose is
the option premium plus transaction costs. Thus, in the preceding
example, the most you could have lost -- no matter how wrong
you might have been about the direction and timing of interest
rates and bond prices -- would have been the $2,000 premium
you paid for the option plus transaction costs. In contrast
if you had an outright long position in the underlying futures
contract, your potential loss would be unlimited.

It should be pointed out, however, that while an option
buyer has a limited risk (the loss of the option premium),
his profit potential is reduced by the amount of the premium.
In the example, the option buyer realized a net profit of
$4,000. For someone with an outright long position in the
June T-bond futures contract, an increase in the futures price
from 82 to 88 would have yielded a net profit of $6,000 less
transaction costs.

Although an option buyer cannot lose more than the premium
paid for the option, he can lose the entire amount of the
premium. This will be the case if an option held until expiration
is not worthwhile to exercise.

Buying Put Options

Whereas a call option conveys the right to purchase (go
long) a particular futures contract at a specified price,
a put option conveys the right to sell (go short) a particular
futures contract at a specified price. Put options can be
purchased to profit from an anticipated price decrease. As
in the case of call options, the most that a put option buyer
can lose, if he is wrong about the direction or timing of
the price change, is the option premium plus transaction costs.

Example: Expecting a decline in the price of gold, you pay
a premium of $1,000 to purchase an October 320 gold put option.
The option gives you the right to sell a 100 ounce gold futures
contract for $320 an ounce.

Assume that, at expiration, the October futures price has -- as
you expected-declined to $290 an ounce. The option giving
you the right to sell at $320 can thus be sold or exercised
at a gain of $30 an ounce. On 100 ounces, that's $3,000. After
subtracting $1,000 paid for the option, your net profit comes
to $2,000.

Had you been wrong about the direction or timing of a change
in the gold futures price, the most you could have lost would
have been the $1,000 premium paid for the option plus transaction
costs. However, you could have lost the entire premium.

How Option Premiums
are Determined

Option premiums are determined the same way futures prices
are determined, through active competition between buyers
and sellers. Three major variables influence the premium for
a given option:

The option's exercise price, or, more specifically, the
relationship between the exercise price and the current price
of the underlying futures contract. All else being equal,
an option that is already worthwhile to exercise (known as
an "in-the-money" option) commands a higher premium
than an option that is not yet worthwhile to exercise (an
"out-of-the-money" option). For example, if a gold
contract is currently selling at $295 an ounce, a put option
conveying the right to sell gold at $320 an ounce is more
valuable than a put option that conveys the right to sell
gold at only $300 an ounce.

The length of time remaining until expiration. All else being
equal, an option with a long period of time remaining until
expiration commands a higher premium than an option with a
short period of time remaining until expiration because it
has more time in which to become profitable. Said another
way, an option is an eroding asset. Its time value declines
as it approaches expiration.

The volatility of the underlying futures contract. All rise
being equal, the greater the volatility the higher the option
premium. In a volatile market, the option stands a greater
chance of becoming profitable to exercise.

Selling Options

At this point, you might well ask, who sells the options
that option buyers purchase? The answer is that options are
sold by other market participants known as option writers,
or grantors. Their sole reason for writing options is to earn
the premium paid by the option buyer. If the option expires
without being exercised (which is what the option writer hopes
will happen), the writer retains the full amount of the premium.
If the option buyer exercises the option, however, the writer
must pay the difference between the market value and the exercise
price.

It should be emphasized and clearly recognized that unlike
an option buyer who has a limited risk (the loss of the option
premium), the writer of an option has unlimited risk. This
is because any gain realized by the option buyer if and when
he exercises the option will become a loss for the option
writer.

Reward

Risk

Option Buyer

Except for option premiums, an option buyer has
the same profit potential as someone with an outright
long or short position in the underlying futures contract.

An option maximum loss: is the premium paid for
the option

Option Writer

An option writer's maximum profit is premium received
for writing the option

An option writer's loss is unlimited. Except for
the premium received, risk is the same as having an
outright position in the underlying futures contract.

In Closing

The foregoing is, at most, a brief and incomplete discussion
of a complex topic. Commodity futures options trading has its own vocabulary
and its own trade algorithm. If you wish to consider trading in
options on futures contracts, you should discuss the possibility
with your broker and read and thoroughly understand the Options
Disclosure Document which commodity brokers are required to provide.
In addition, have your broker provide you with trader education
and other literature prepared by the exchanges on which options
are traded. Or contact the exchange directly. A number of
excellent publications are available.

In no way should anything discussed here be considered
trading advice or trade recommendations. Trading advice should
be provided by your broker or commodity trading advisor (CTA).
Your commodity broker or a commodity trading advisor, as well
as commodity exchanges where futures contracts are traded,
are your best trading knowledge sources for additional, more
detailed facts and information about commodities trading and commodity futures day-trading.

This
special report on commodity futures trading is offered as
a public service to
commodities futures traders by: National Futures Assn, 200 W Madison St., Chicago, IL 60606
USA